Debate rages over future of commodities bull run

Bill Miller, who knows a thing or two about investing, sees today's red-hot commodity market as a fool's paradise.

Miller, one of Wall Street's winningest stock-pickers of the last 20 years, last week wrote a blistering essay on the risks of jumping aboard the wild bull market in commodities such as oil, gold and copper.

"The time to own commodities is, or at least has been, when they are down, when everybody has lost money in them, and when they trade below the cost of production," Miller wrote. "That time is not now."

There is a tinge of sour grapes in Miller's tone. Commodities have never been his style. Miller's $20-billion-asset Legg Mason Value Trust mutual fund has substantial stakes in Internet-related companies, including eBay Inc. and Amazon.com Inc., and in big blue chips such as Citigroup Inc. and Home Depot Inc.

The Baltimore-based fund is down 1.7 percent year to date. By contrast, a Morgan Stanley index of 20 major commodity-related stocks is up 17 percent. On Wall Street, as in Hollywood, it never feels good to miss a big party.

Since 1989, however, Miller's fund has risen 13.7 percent a year, on average, compared with a 10.6 percent average annual gain for the Standard & Poor's 500 index.

So when he talks, people pay attention.

His message on commodities is simple enough: It's probably too late to get in.

"The excitement and enthusiasm surrounding commodities, and the belief that they will continue to rise, is not surprising," Miller said. "People want to buy today what they should have bought five or six years ago."

No doubt the 56-year-old Miller is reflecting the frustration level of many investors who have sat out the bull run in raw materials since 2002.

But Miller could be way too early in calling a peak in commodities, said Bob Howard, who writes the investment newsletter Positive Patterns from Springfield, Mo., and who has been pounding the table for many raw-materials stocks since at least 2004.

Prices in any free market ultimately are a function of supply and demand, Howard said.

Look around the world at demand for oil and other commodities, he said. Then look at supplies.

"Yes, at some point production will become such that it meets and exceeds demand, but for many commodities this may be years away," Howard said.

In the 1980s and 1990s, commodity investing was mostly a loser's game. Buying and holding stocks, on the other hand, was spectacularly lucrative in that era.

But for the last few years, the commodity market has been the buy-and-hold investor's dream.

Oil is up 127 percent since the end of 2002. Copper is up 366 percent, sugar 125 percent, gold 82 percent and coffee 80 percent.

The S&P 500 index's total return since then: 58 percent.

The thumbnail explanation for the commodity boom is well known. After mostly falling for 20 years, raw materials prices began to rebound in 2002 as demand soared in China, India and other emerging economies.

And because there was little incentive for commodity producers to hunt for new sources of those raw materials in the '80s and '90s, they weren't prepared to meet the sudden increase in demand.

Now, even with prices up sharply, supply remains a problem, commodity bulls say. As with oil, it is much more difficult worldwide to find and produce many raw materials than it was, say, 20 years ago.

But to be optimistic on commodities, you can't just assume that supplies will remain restricted. You also have to believe that demand will stay strong. And on that issue, in particular, Miller is dubious.

"What the commodity bulls implicitly assume is that higher prices will not curtail demand," he said.

China's central bank sent a shudder through commodity markets on Thursday, when policymakers raised their benchmark interest rates in an attempt to slow the economy's breakneck pace.

Any deceleration in China's growth rate could send raw materials prices tumbling, if only because short-term speculators who have been riding the commodity bull market might decide they've had enough fun for now.

Yet some commodity bulls say one of the best arguments for keeping the faith is that many investors are in Miller's camp, disbelieving that the raw-materials rally can be sustained.

Peter Schiff, president of money management firm Euro Pacific Capital Inc. in Darien, Conn., is a big fan of gold, even with the price around a 25-year high of $630 an ounce.

Popular culture has yet to embrace gold's bull market, Schiff said. If metals investing were a true speculative bubble, he said, "Taxi drivers would be offering tips on mining companies."

Miller, however, believes that Wall Street's fascination with the commodity story is far more intense than Schiff would allow.

In any case, he said, "I can't help but be skeptical of the advice to start or increase a position in commodities after the biggest bull move in 50 years."